Don't believe the hype: drop it like it's hot. When it comes to oil, sell the news.
Rumors of a cease fire in the Israel-Gaza conflict dropped West Texas Intermediate crude oil over 3 percent percent midday Tuesday. This despite the fact that very little oil is produced in the conflict area. Why, then, does oil respond to Israel-Gaza news? Well, the concept is that other factions could be pulled into the conflict as the situation potentially escalates. Nations that actually do produce oil could thus become affected.
Let's look at the broader situation for oil, however. The oil market as a whole is well-stocked. In fact, here in the U.S., stockpiles are at four-month highs. And demand for oil in Europe, Asia and the U.S. is relatively weak.
So this is really about the possibility that we will see a closing of the Strait of Hormuz if Iran gets involved. Who would lose the most in that scenario? The producers of oil: Iran and Saudi Arabia. Remember, most of the Middle East counts on the revenue from shipments of oil. Iran is in no position to cut that revenue, given that the nation is already reeling from runaway inflation, as well as internal political pressures. Unfortunately, this is simply politics, Middle East style.
(Read More: OPEC Says 2013 Oil Demand May Underperform.)
Most analysts agree that there is at least $10 of risk premium in the market today. In other words, worries about the Middle East are pushing the price of crude up by about $10 a barrel. We could cut that risk premium in half, and drop another 6 percent, if an Israel-Gaza deal is done.
Now let's look at the levels.
Major support in the crude market comes in around $82.50. If you want to play the short side of the market, consider buying the CL Jan13 $82.50 puts for total risk of $750. You will have 23 days until expiration. Food for thought.
Read on for 10 Things You Need to Know to Trade Futures
Questions? Comments? FuturesNow@CNBC.com
When this story was published, Ilczyszyn owned January WTI 80-strike puts.